In this article, we consider the new Subchapter V of Chapter 11, which is open to small businesses with under $7.5 Million in debt.
With minimal fanfare, the Small Business Reorganization Act (SBRA) was passed in August 2019, to come into effect in February 2020, ushering in Subchapter V of Chapter 11. Nobody could have predicted how critical this timing would be; the consequences of COVID-19 crippling many small businesses just one month later.
This Small Business Reorganization Act (SBRA) is now commonly referred to as Subchapter V. This SBRA was designed to streamline existing bankruptcy procedures and provide new tools to increase a small business’ ability to achieve a successful restructuring.
When the SBRA was first passed in 2019, companies could only qualify for Subchapter V with less than $2.7 Million in total noncontingent, liquidated, and non-insider debt debts, but with COVID-19 and the CARES Act passing on March 27, 2020, this threshold was increased to $7.5 Million allowing for larger businesses to also qualify, but with a 12-month sunset.
Why is Subchapter V important to a small business?
In simple terms, a small business owner now has significantly increased leverage to negotiate with all their creditors.
The Small Business Reorganization Act shifts leverage in favor of the business owner in several key areas.
1) Under SBRA / Subchapter V, a business owner can submit a plan of reorganization without the consent of any creditor.
2) Only the business owner (debtor) has the right to modify the restructuring plan post confirmation.
3) A small business owner has relief from the absolute priority rule.
4) SBRA / Subchapter V is significantly cheaper and faster, with fewer hurdles and fewer fees.
1) Under SBRA / Subchapter V, a business owner can submit a plan of reorganization without the consent of any creditor.
Under regular Chapter 11 rules for large companies, creditors are required to consent to the restructuring plan, so they hold leverage against the business owner (debtor). This is not true under Subchapter V. While creditor consent is helpful, it is not required, reducing creditor leverage against the business owner. The Subchapter V Trustee will assist the debtor in negotiating an acceptable plan with creditors, but if creditors refuse to negotiate or don’t accept terms then the debtor can submit a plan without creditor consent.
2) Only the business owner (debtor) has the right to modify the restructuring plan post confirmation.
In a Chapter 11, a creditor has a right to file a competing plan, but this is not allowable under SBRA rules, so the business owner (debtor) has greater control of the restructuring process.
3) A small business owner has relief from the absolute priority rule.
In a traditional Chapter 11, the owner of the company either has to provide unsecured creditors with a guarantee they get paid in full or the business owner (debtor) has to give up their equity in the company, with a chance to buy it back later. That absolute priority rule is now gone, so the business owner doesn’t have to give up their stock. This shift from “absolute priority” to “best efforts” is a significantly lower threshold. The business owner can retain their equity in the business without paying unsecured creditors in full, provided the business commits all of its “projected disposable income” to paying creditors for a minimum of three and a maximum of five years.
4) SBRA / Subchapter V is significantly cheaper and faster, with fewer hurdles and fewer fees.
Chapter 11 could cost tens of thousands to hundreds of thousands of dollars to complete and Subchapter V eliminates most of these fees. While a Subchapter V Trustee is required in the first 90 days to assist in developing a consensual plan, there is no need to continue engaging a Trustee if the restructuring plan has consent of creditors, which saves considerable costs. A restructuring plan is still required; however, there is no disclosure statement requirement, which saves another costly exercise. Subchapter V also has a one-step restructuring plan solicitation and confirmation by the Court. In a traditional Chapter 11 case, administrative expenses must be paid at plan confirmation, but under Subchapter V, they may be paid over the 3 to 5-year life of the plan. The goal of SBRA / Subchapter V is to complete the restructuring plan within 90 days and then confirm the plan within 30 days, versus a traditional Chapter 11, which can take months or sometimes years.
What is the benefit to a business owner of SBRA / Subchapter V?
Creditors understand they now have less leverage. Consequently, the creditor has a greater incentive to come to the negotiating table on debt relief rather than force a restructuring plan under Subchapter V, which is more debtor friendly. Our expectation is that many more small businesses can complete a successful out of court restructuring by negotiating early with creditors and have a higher likelihood of successfully emerging from the restructuring process with the operating business intact.
Timing of Filing Subchapter V
Subchapter V may allow small businesses to freeze their obligations to allow them to negotiate with lenders, landlords, and other creditors and hopefully resume normal operations once the immediate financial distress subsides. However, small businesses should carefully consider the timing of a Subchapter V filing as businesses presently subject to a bankruptcy proceeding are ineligible for the Paycheck Protection Program (PPP). Subchapter V filings are likely to surge once PPP funds run out, particularly among businesses that are unable to meet the loan forgiveness criteria.
In consideration of Subchapter V, you first need to determine whether your business qualifies. There are several additional criteria beyond the $7.5 Million debt cap – call us and we’ll walk you through it. There are other intricacies not described above; we wanted to highlight the critical areas and discuss in greater depth as needed.
We are here to help.
www.clearridgecapital.com/what-we-do/restructuring/
Note: SBRA and Subchapter V of Chapter is still a complicated process. We would recommend a preliminary discussion with ClearRidge, as well as experienced bankruptcy counsel. ClearRidge is outlining topics for business owners to consider in their business continuity and survival strategies for information purposes only. Nothing contained herein should be construed as legal advice. ClearRidge will work in a coordinated effort with experienced bankruptcy counsel to plan the most effective options and outcomes for you in an out of court restructuring or bankruptcy process.
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